Now we’re talking! Nick Rowe has a new post up responding to my claim that the medium of account (MOA) is the essence of money, not the medium of exchange (MOE.) Nick disagrees, as do all the other market monetarists who have weighed in. But that’s never stopped me before. Let’s think of a basic monetary model of the price level:

P = Ms/(Md/P), Where Ms = Md.

Oops, that’s a tautology, not a model. Let’s try again:

Md/P = f(i, Y) Where real (base) money demand is negatively related to i and positively related to Y.

Ms is set by the Fed.

Now consider what we mean by “M.” If M is the medium of account, but not the medium of exchange (as in my Zimbabwe example) then the model works fine. If M is the MOE but not the MOA, then it doesn’t work at all.

Here’s Nick:

Scott Sumner argues that it is the medium of account function that matters. My view is different. Here is my view:

Demand and supply of the medium of account determine the equilibrium price level.

Demand and supply of the medium of exchange determine whether the economy is in a boom or a recession.

If the MOA determines the equilibrium price level, then ipso facto it determines NGDP. So unless I’m mistaken Nick agrees that the market for the MOA determines NGDP. I claim that business cycles are caused by NGDP shocks in the presence of nominal wage stickiness, or perhaps both wage and price stickiness. Once one accepts that MOA shocks cause NGDP shocks, it seems to me that the battle is over. In my Zimbabwe example the MOA got more valuable due to higher gold demand, and the MOE got almost worthless from excessive money printing, and yet Zimbabwe experienced deflation as the Z$ price of gold soared. But maybe I am missing something.

Nick’s a very smart guy who knows monetary economics better than I do, so let’s try to figure out where the disagreement comes from:

1. I look at recessions as big drops in output, associated with involuntary unemployment. I am pretty sure that Nick views them as big drops in spending, where monopolistically competitive firms are not able to find buyers. Perhaps that’s why he focuses on the MOE. But in the end, gross domestic expenditure equals gross domestic production. So that really shouldn’t be the decisive difference.

2. Nick seems to assume a disequilibrium model, whereas I assume the MOA and MOE markets are continually in equilibrium. Here’s Nick:

But what determines Y when we are out of equilibrium, because the Emperor Diocletian has issued an edict forbidding any price changes?

Thought-experiment 1. Start in equilibrium, hold all prices (update: both Ph and Ps) fixed, then halve the stock of gold (medium of account). What happens?

There is an excess demand for gold in the gold market, but nothing else happens. The market for haircuts continues as before. People want to sell some of their silver for gold, but they can’t, because nobody wants to take the other side of the trade. The production and sale of haircuts for silver continues just as before, because there is no change in the relative demands for silver and haircuts. There is no change in the marginal utility of silver, the marginal utility of getting a haircut, or the relative price of haircuts and silver Ph/Ps. So trade of silver for haircuts continues just as before.

An excess demand for the medium of account does not cause a recession.

But why would the gold (or money) market ever be in disequilibrium? In the early 1930s when a big increase in the demand for the medium of account (gold) was causing worldwide deflation and depression (remember sticky wages), anyone could freely get gold any time they wanted it. There was no shortage at all. Indeed the same is true for currency, which is easily available via ATMs, even when a reduction in the growth rate in the currency stock is triggering a recession (as in late 2007 and early 2008.) A shortage is very different from a reduction in supply. A shortage means people are unable to hold the currency or gold balances that they wish to hold.

But what if prices are sticky in the short run? In that case wouldn’t a big reduction in gold, or currency, cause a shortage of that MOA? No, interest rates are flexible, and the liquidity effect of interest rates is what equilibrates the MOA market until prices have had time to adjust. Then over time NGDP begins to fall, so people don’t need as much MOA, and thus interest rates begin to fall. In the very long run the NGDP will adjust by enough to fully offset the MOA shock, and interest rates will return to their original level. At no time is the MOA market out of equilibrium, it’s just that different variables are equilibrating the market; first interest rates (the opportunity cost of holding MOA), and then NGDP, and in the long run only prices change—money is neutral in the long run.

I can’t make sense of macro unless I think in terms of one set of markets always being in equilibrium (stocks, bonds, forex, currency, gold, etc) and another set of markets being out of equilibrium during business cycles (labor, and perhaps some monopolistically competitive goods.) My opponents talk about scenarios where it seems like almost everything is out of equilibrium. I’m just not smart enough to figure out what’s going on in that case—it’s like trying to keep track of all the leaves swirling outside my window last night.

One other point. Assume there is a negative gold market shock, and gold is the MOA but not the MOE. Also assume a dual MOA, with paper currency being the MOE. I do realize that in order to maintain convertibility the central bank may have to reduce the currency stock, and that this could be viewed as causing a recession. Indeed this is precisely what happened in Canada in the early 1930s. But it’s very strange to attribute that early 1930s deflation/depression to a falling Canadian currency stock. That response was endogenous. Rather it makes more sense to view the global hoarding of gold as the cause of the Canadian deflation. After all, why would the Canadian central bank decide to run a highly contractionary monetary policy in the early 1930s?

When there is a negative monetary shock from the MOA market, lots of other things will happen. The nominal interest rate might shoot up in the short run. And the Keynesians will say monetary policy is really all about interest rates. The central bank will be forced to contract the currency stock, and the non-Sumnerian (non-insane?) market monetarists will say monetary policy is all about adjustments in the stock of MOE, relative to shifts in demand for MOE. But isn’t the heart of the matter that the MOA got more valuable, forcing global deflation on any country using gold as the MOA?

There is a Canadian Nobel laureate in economics who would understand my argument. His Nobel lecture claimed that the Great Depression was caused by too much demand for gold. Maybe he’ll leave a comment.

Perhaps you can ask yourself why you favor monetary policy (money inflation) to be used to target NGDP (which is a spending, MoE concept) rather than something like aggregate balance sheet assets (which is an MoA concept).

If NGDP is the important goal of monetary policy to you, then aren’t you saying tacitly holding that money is primarily a MoE?

When there is a negative monetary shock from the MOA market, lots of other things will happen. The nominal interest rate might shoot up in the short run. And the Keynesians will say monetary policy is really all about interest rates. The central bank will be forced to contract the currency stock, and the non-Sumnerian (non-insane?) market monetarists will say monetary policy is all about adjustments in the stock of MOE, relative to shifts in demand for MOE. But isn’t the heart of the matter that the MOA got more valuable, forcing global deflation on any country using gold as the MOA?

Doesn’t the MoA become more “valuable” (measured in money terms) by way of more MoE?

In the Zimbabwe example, there is exchange money and account money. In your example you assume that there is very good information regarding their relative values… and I assume their future relative value. Would you be willing to borrow money “account money”, to build out your facility, pay your workers in “exchange money” and receive future “exchange money” if you were uncertain of the future value of exchange money relative to account money? An increase in supply of exchange money would threaten a recession.

Ms is set by the fed… is it? Money is checkable deposits, and money funds CDs and CP, and REPOs, and T-Bills….The fed prints currency, banks create money, and the Fed regulates banks. The Fed can attempt to manipulate the supply but they do not set the supply.

“But why would the gold (or money) market ever be in disequilibrium?”

When the government fixes the exchange rate between the different kinds of money. If there is a perception that one sort of money is better than the other but the exchange rate is fixed, people will hoard the good money and trade in the bad money. The bad forces out the good. — Greshams law

“In the early 1930s when a big increase in the demand for the medium of account (gold) was causing worldwide deflation and depression (remember sticky wages), anyone could freely get gold any time they wanted it.”

No they couldn’t! — “hoarding” gold was illegal.

I am not sure I am buying into this idea that it is possible to completely divorce the unit of account from the medium of exchange. We have agreed that debts are tied to the unit of account. But, then what does this stuff in my pocket say on it?

No, gold hoarding wa not illegal in the early 1930s, only after March 1933. And no, I am not assuming a government set exchange rate between gold and the MOE. If the government does set a fixed rate, they need to make the MOE endogenous.

Your money is not legal tender for all debts, only for dollar-denominated debts.

Scott: Yep. We are now big enough to split into factions. Like some of those crazy lefty political parties!

This is how i responded to 123, when he asked what would happen in my model if I kept the price of haircuts Ph fixed, but let the price of silver Ps, adjust to clear the market for gold:

‘Let’s suppose Ph is fixed, but now suppose Diocletian goes soft and lets Ps adjust when he sees what happens.

Thought-experiment 1. Ps falls because there’s an excess demand for gold, which from equation 2 reduces the real value (in terms of haircuts) of the stock of silver, which creates an excess demand for silver in terms of haircuts, which causes a recession.

Thought-experiment 2. Ps rises because there’s an excess demand for silver in terms of gold, which increases the real stock of silver in terms of haircuts, which eliminates the excess demand for silver, which ends the recession.’

Perhaps that reconciles our differences, at least in part? I would insist that it is an excess demand/supply of the MOE that causes recessions/booms. But I would allow that, provided the price of the MOE is perfectly flexible, there cannot be an excess demand for the MOE unless there is also an excess demand for the MOA?

(Yes, the imperfect competition stuff in my model isn’t essential for this argument. But it is handy for making my model symmetric, because with imperfect competition an excess supply of the MOE will also cause a boom. Under perfect competition, you can’t increase output higher than the flexible price equilibrium).

Nick, I’m going to have to do some thinking and come back on the silver question later. I still haven’t fully processed your post. But a few quick responses on other points:

1. I completely agree on the peanut butter example. I’m all for assuming disequilibrium in labor markets, and in most product markets. We both agree that sticky wages and prices are the sine qua non of recessions, we differ slightly on exactly why.

I am assuming that people can get currency to spend by selling other financial assets, which have flexible prices. This is what gives you the liquidity effect (fall in short term rates) when the Fed injects new money into the economy, even if by helicopter.

We both have models that are symmetrical, that can explain both booms and recessions. That’s because we both assume sticky wages and prices. Indeed sticky wages alone will get you that symmetical result, even if output was sold in perfectly competitive industries (which is obviously not the case in general.)

I’ll come back later tonight with comments on silver—first I must finish grading.

When I read Rowe, it was the MOA determines the _equilibrium_ price level.

The MOE is responsible for the disequilibrium phenomenon of the boom and bust. (And we are really more interested in bust.)

If you give the MOE its own price in terms of the MOA, and assume that the price always adjusts to keep the quantity of money equal to the demand for money, then there are no shortages of money to cause recessions.

As for the MOA, I don’t doubt that shortages of it will cause recessions. But they cause the shortages through a shortage of money. No shortage of money, and the market for the MOA just doesn’t clear.

Shortages of money don’t appear as people looking around for money, and finding the shelves in the money shop empty. They show up as reduced spending on other things, most importantly output.

It is the nature of the medium of exchange.

In my view, your are are too focused on equilibrium and not focused on the process by which the market moves towards equilibrium.

Argh! Every time Scott posts/comments, I think he’s right. Then when Nick and Bill comment, I think they’re right.

Surely someone good at math can adapt the Separating Hyperplane Theorem to demonstrate that the MoA and MoE views are mathematically equivalent under some set of assumptions about the market for MoE as denominated in MoA?

Can someone clarify what the exact definition of a medium of exchange v a medium of account is ?

In Scott’s example Zimbabwe people get paid in the MoA and in Nick’s example people desire the MoA because they value it as jewellery. They are used for purposes other than just accounting. It seems that in both cases M0A and MoE are more like competing currencies/commodities with a few legal rules or customs determining what they will be used for.

If sticky prices cause recessions it seems that whichever of the competing currencies are used for trading the goods with those sticky prices will cause the recession.

In Scott’s model MoA could cause a recession if wages are sticky (since they are paid in MoA). In Nick’s model MoE could cause a recession since haircuts are paid for in this currency and have sticky prices.

Its seems that no good could ever be traded for a “true” MoA and so by definition could not cause a recession, but perhaps I am not understanding what MoA means.

Some observers argue that the Fed has done too much, has been too accommodative. I strongly disagree. … In light of the unusually large macroeconomic shock, I believe that it is misleading to assess the FOMC’s actions by comparing its current choices to policy steps taken over the past 30 years. Instead, we have to assess monetary policy by comparing the economy’s performance relative to the FOMC’s goals of price stability and maximum employment. In particular, if the FOMC’s policy is too accommodative, that should manifest itself in inflation above the Fed’s target of 2 percent. This has not been true over the past year: Personal consumption expenditure inflation””including food and energy””is running closer to 1.5 percent than the Fed’s target of 2 percent.

But this comparison using inflation over the past year is at best incomplete. Current monetary policy is typically thought to affect inflation with a one- to two-year lag. This means that we should always judge the appropriateness of current monetary policy using our best possible forecast of inflation, not current inflation. Along those lines, most FOMC participants expect that inflation will remain at or below 2 percent over the next one to two years. Given how high unemployment is expected to remain over the next few years, these inflation forecasts suggest that monetary policy is, if anything, too tight, not too easy.

Never reason from an interest rate change! Assess policy’s tightness or looseness by actual results! Target the forecast! All he needs to do now is drop those magic 4 letters somewhere in there and talk up prediction markets/rational expectations (what long and variable lags?)…

“This means that we should always judge the appropriateness of current monetary policy using our best possible forecast of inflation, not current inflation. Along those lines, most FOMC participants expect that inflation will remain at or below 2 percent over the next one to two years. Given how high unemployment is expected to remain over the next few years, these inflation forecasts suggest that monetary policy is, if anything, too tight, not too easy.”

Fed Up (so am I): “What if people decide to stop using currency and use only demand deposits?”

The Fed determines the size of the monetary base, the public determines the split between currency and bank reserves. The stock of demand deposits is constrained by the stock of bank reserves (even without reserve requirements).

I don’t know if I should bother continuing to post comments here, I don’t know how Scott could possibly have written that last post if he had read all my comments on the previous two.

“Once one accepts that MOA shocks cause NGDP shocks, it seems to me that the battle is over.”

Our claim:

Suppose there is a MoA. Suppose there is no MoE. (And there is no credit, so screw your goddamn interest rates.)

The value of the MoA determines the price level. The MoA has nothing to do with the level of real output consumed.

If the price level, which is the inverse of the “price” of the MoA, is fixed, then the value of the MoA is fixed. The MoA does not determine NGDP.

If the price level, which is the inverse of the “price” of the MoA, is flexible, then the value of the MoA is flexible. The MoA determines P, and consequently NGDP. The MoA still does not determine Y.

Since the “price” of the MoA is fixed (because the price level is fixed), changes in the supply or demand for MoA will leave the MoA market in disequilibrium (unless supply and demand shift the same amount). The price of MoA cannot adjust, because it is fixed, because the price level is fixed.

Supppose it is an excess demand for money. This disequilibrium is called a “general glut” of goods for money. If money were a MoE, this would be a recession, as the outputs could not be sold to their final consumers.

But there is no MoE. “Money” here is just a MoA. So the glut of goods being exchanged for money is irrelevant. The MoA is not required to get goods to their final consumers. They are simply bartered for each other. There is no recession. NGDP does not fall.

(Get it? Because recessions are when you can’t exchange goods for each other. The output gap in the US economy right now is stuff that can be produced, but not exchanged into the hands of their final consumers. Because there’s no flow of money to buy them with. Exchange needs a medium, but misses it. The MoA determines the nominal size of the available MoE, and affects things that way. But without MoE, MoA determines the price level (when flexible) but has nothing to do with the level of output consumed.)

The MoA does not determine “NGDP”. It determines P, when P is flexible. Because P is the inverse of the price of MoA.

…

Suppose now that instead of exchanging MoA directly for Y, we exchange it for a separate MoE (“silver”). There is excess demand for MoA. The price level is still fixed. But the relative prices of MoA and MoE are flexible. Now the MoA is free to appreciate, in terms of MoE. And hence the nominal value of MoE depreciates.

But the price level is fixed, so now there isn’t enough MoE to buy all the Y. So there is a recession.

In this case, MoA was able to determine NGDP. Even though P was fixed. Because there was an MoE present to lose value as the MoA appreciated. And then the disequilibrium between (nominally) less MoE, and Y, did cause a recession. Because the MoE is required to sell stuff. Unlike the MoA.

If the price level is fixed (enabling recessions) then something will be in disequilibrium (duh) with Y. If it’s the MoA, this won’t affect Y consumed. If it’s the MoE, it will. The MoA can only play a role when P is fixed, by reducing the effective supply of MoE. Otherwise it’s irrelevant. (As P is already fixed.)

“Then over time NGDP begins to fall, so people don’t need as much MOA, and thus interest rates begin to fall.”

Assume P is still stuck. Then for NGDP to fall, Y must be falling. But it won’t. Because the MoA has nothing to do with the amount of Y sold. Unless there is a MoE…

“I can’t make sense of macro…”

Don’t worry, neither can most economists.

{To clarify, if wages are rigid downwards, then prices will be nearly as rigid downwards. Even at (nearly) the same real wage, firms will demand less labor. The reason being, because the product market is also out of equilibrium (with the MoE supply). Even if firms are perfectly competitive.}

“His Nobel lecture claimed that the Great Depression was caused by too much demand for gold.”

But it was! We totally agree on that.

“… isn’t the heart of the matter that the MOA got more valuable, forcing global deflation on any country using gold as the MOA?”

Sort of. I think what we’ve learned is that there’s a good reason why we just have one money which is both MoA and MoE – it avoids this controversy. (Talk about the MoneyIllusion!)

“I’m just not smart enough to figure out what’s going on in that case”

Scott, I’m dumber than you, and I figured this stuff out myself (eventually with a little help from Nick Rowe’s blog). You can do it, too!

Put it this way. There’s 2 ways gold can “be the MoA”. We could denominate all prices in gold. Or we could maintain a fixed exchange rate between gold and whatever prices are denominated in.

Either way, a rise in the real value of gold (relative to goods) will push down prices (and employment, when there is a MoE). It will do so by reducing the nominal value of the currency stock.

If we had denominated prices in gold-ounces, and left the gold-currency exchange rate flexible, appreciating gold reduces the nominal value of the same stock of currency-dollars.

If we denominate prices in currency (bearing the number of dollars asked), and fix the gold-currency exchange rate (so a dollar is always worth the same number of gold-ounces), then a rise in the real value of gold corresponds to a reduction in the nominal currency stock. This time, because of a lower physical quantity of currency.

If we denominate prices in currency, bearing the number of dollars asked, and float the gold-currency exchange rate – then gold is irrelevant to NGDP. (Provided gold isn’t the MoE.)

Dude, remember what people started doing during the Great Depression, when the monetary authorities were denying them money? They started to barter. And issue their own scrip. Probably at the same price level.

I hope this doesn’t mean you have to revise your Great Depression manuscript…

“But it’s very strange to attribute that early 1930s deflation/depression to a falling Canadian currency stock. That response was endogenous.”

It’s like saying, “What the central bank really really does is set the price of credit, so when the price of credit falls, the response of contracting the money supply is purely endogenous. (But we all know that it’s really the demand and supply for credit that really causes recessions.)

Bill: If you give the MOE its own price in terms of the MOA, and assume that the price always adjusts to keep the quantity of money equal to the demand for money, then there are no shortages of money to cause recessions.

But the demand for MoE comes from the haircuts (sorry, goods) market. For the MoE/MoA market to equilibriate to restore equilibrium in the goods market, you need flexible supplies of MoE or MoA.

OTOH if there is a collapse in the MoA stock, MoE stock constant, then if the price adjusts the nominal value of MoE falls, and a recession occurs. And increasing the MoE stock won’t fix this, only increasing the MoA stock will.

Shortages of money don’t appear as people looking around for money, and finding the shelves in the money shop empty. They show up as reduced spending on other things, most importantly output.

Or in other words, equilibrium in stocks is restored by a contraction in flows. And that leads to a disequilbrium between money flows and output waiting to be sold.

Kevin: Surely someone good at math can adapt the Separating Hyperplane Theorem to demonstrate that the MoA and MoE views are mathematically equivalent under some set of assumptions about the market for MoE as denominated in MoA?

Yes, they are (nearly) equivalent when MoE is traded for MoA. Read my earlier comments (though by now they might be harder to sort through than the Separating Hyperplane Theorem).

Nick, can you please also explain to Scott that velocity is the rate at which money turns over (on average), because it is the inverse of the desired stock of money in equilibrium (as a fraction of nominal income)?

Obviously the root problem is that Scott doesn’t actually visualize anything. His brain is just not that mathematical.

People shouldn’t treat Scott Sumner like Samuel Johnson – they should call him out on his mistakes, even though he is right about everything else. Even at pain of expulsion from his sidebar. That’s how the cults start, otherwise.

Aaargh, Nick, I forgot about that post! That’s the one I meant to link to, it’s the most appropriate one! Scott still believes in the peanut theory of recessions. His peanut is the medium of account, and its effect on the price level. Except he fudges this together with actual effects of money on real output, and starts talking about the medium of account determining “NGDP”… (which it does, if it controls the nominal value of the medium of exchange…)

I think I (luckily) avoided the confusion that grips the economic profession, through a random event at the beginning of my economic education. When thinking about the macroeconomy for the first time, I just immediately latched on to the correct intuition – and never let it go.

I forgot to forget about money.

Most other students would have been like, “Sure, we buy sell things for money. I sell chickens for money, and buy bread with that money. I’m selling chickens for money. Forget the money.” Then when recessions come along, some people say markets clear unless the government starts passing Obamacare, so that’s why the recession happened. Others say it must be a desire for people to buy bonds. The unsatisfied bond demands are the recession.

So the output market shows an excess supply of output matched by an excess demand for money (by firms). But firms don’t want to hold that money; they want to spend it on labour and distribute the remainder to households as profits. And the labour market shows an excess supply of labour matched by an excess demand for money (by households). But households don’t want to hold (all) that money; they want to spend (most of) it on output.

The excess demand for the stock of money GETS RESOLVED, at a lower level of income. Then there is an excess demand for monetary FLOWS. Whose demands are these? Why, the demands of everybody in the economy right now who is unable to sell everything they can produce.

The recession IS the excess demand for money.

I think we may have hit the cognitive-theoretical limit to simplicity of explanation, here. I certainly can’t do any better.

There is an excess demand for money in the output market. And another excess demand for money in the labour market. But this does not mean that firms and households want to hold more money; if they got it they would want to spend it (or most of it). So the central bank would not need to create anywhere near as much money as those excess demands for money would indicate. It is logically conceivable that a single $1 would be sufficient to eliminate trillions of dollars excess supply of goods.

Nick, I took another look at your post, and it seems the key difference is that you assume the MOA is out of equilibrium. In that case you are right. But . . .

1. In the real world MOA were not out of equilibrium, even during depressions, and even when prices were sticky. The increase in demand for gold did cause NGDP to fall sharply in the early 1930s. And that resulted in both lower P and lower Y. Next year I have a book coming out that is pretty much 100% devoted to showing that.

2. I assume the market for the MOA is in equilibrium (in terms of the MOE.) And in that case I’m pretty sure that I am right. A huge rise in the demand for gold makes the silver price of gold soar. That reduces the stock of MOE when priced in MOA terms. Since goods are priced in MOA terms, that’s very deflationary. QED?

David, In the real world I view cash and reserves as both MOE and MOA. In my Zimbabwe example they are only MOE, not MOA.

Things like checking acount balances are MOE but I don’t view them as MOA. When you bring a check to the bank teller’s window and say “give me some money for this” you don’t want them to hand you right back the check.

Bill and Nick, I don’t believe that “shortages of money” cause recessions. I believe that decreases in the supply or increases in the demand for money cause recessions. The money market is in equilibrium, people aren’t runnning around saying” I can’t find an ATM to get the cash I need” or “The line is so long at the ATM.”

There is (would be) a shortage at the existing price level and exisiting interest rate, but the interest rate (and other asset prices) adjusts in milliseconds to a monetary shock to bring the MOA market into a new equilibrium. Hence no money shortage.

Ron, The Zimbabwe miners are not paid in MOA, rather their salary is denominated in MOA, but they are paid in Z$s. Perhaps I misspoke.

Everyone, Thanks for that Johnleemk piece, I’ll do a post. I won’t have time to catch up to all the old comments for a while, or the rest of these comments, as I am super busy today. I hope to get to them tonight. It would help if people framed their comments in terms of my two questions:

1. Does an increases in demand for the MOA cause NGDP to fall? If not, why not? Are you assuming the MOA market is not in equilibrium? If so, what basis do you have for that assumption when in the real world people could freely convert cash to gold, even during deep deflations.

2. If NGDP does fall, and nominal wages are sticky, why doesn’t that cause unemployment?

We both assume nominal wages are sticky. We both then simplify by jumping to the conclusion that the price level is sticky.

In the real world, there is a MoE. The MoA devalues the stock of MoE, creating a shortage of MoE, causing recessions.

If there is no MoE, then the price of the MoA is determined by trading real output for MoA. If the MoA stock is halved, there is excess demand for MoA. The MoA market cannot now move to the new equilibrium, because this would require the price of MoA (in terms of Y, which is on the other side of the market) to rise. But this would imply that the price of Y (P) had fallen. Which it cannot. By assumption.

So MoE causes recessions. And unemployment. Not MoA. An excess demand for MoA has no power to stop people from selling everything they want to sell, and workers from getting all the jobs they want to get.

The shortage of MoE is corrected at lower level of equilbrium real income Y. At this Y, there is equilibrium in the demand and supply of MoE stocks. There is now however disequilibrium in the demand and supply of MoE flows.

Without a MoE, MoA does not determine NGDP. It determines P. And P determines NGDP.

With a MoE (M), MoA determines the nominal size of M. And M times the number of times the M stock is spent on output (on average), determines PY (NGDP).

The MoA looks like it determines NGDP, because normally it is the MoE. So an increase in the value of MoA, is a reduction in the purchasing power of MoE. So not only can MoA determine the price level, but a fixed exchange rate between money and goods (fixed price level) can lead to less MoA/MoE (they are the same now) being spent on buying output. And only the output sold for the MoA/MoE is part of GDP, and NGDP. Because output that can’t be traded for MoE, can’t be consumed. Unlike MoA.

2. I assume the market for the MOA is in equilibrium (in terms of the MOE.) And in that case I’m pretty sure that I am right. A huge rise in the demand for gold makes the silver price of gold soar. That reduces the stock of MOE when priced in MOA terms. Since goods are priced in MOA terms, that’s very deflationary.

See, you get it now. Without an MoE in the picture, there is deflation, but no recession. You see?

If during the Great Depression people had bartered instead of using US currency, then there would have been no Great Depression. Only a Great Deflation, with gold as the MoA.

And gold would only affect nominal prices of things, (including bonds, which would not have cash flows or money-payments associated with them). There would be no liquidity effect on interest rates, as that requires a MoE.

“My opponents talk about scenarios where it seems like almost everything is out of equilibrium. I’m just not smart enough to figure out what’s going on in that case””it’s like trying to keep track of all the leaves swirling outside my window last night.”

Greg, that was Scott nobly admitting his own humility in the face of a problem that seemed too big for him. You cheaply took a shot and used it to make one of your boring hackneyed epistemological points. Shame.

Scott: “2. I assume the market for the MOA is in equilibrium (in terms of the MOE.) And in that case I’m pretty sure that I am right. A huge rise in the demand for gold makes the silver price of gold soar. That reduces the stock of MOE when priced in MOA terms. Since goods are priced in MOA terms, that’s very deflationary. QED?”

We are on the same page. I would say it differently. ‘A huge rise in demand for gold makes the silver price of gold soar, which reduces the real stock of MOE when priced in MOA terms, which creates an excess demand for MOE/excess supply of all other goods that have sticky prices, which is a recession’.

” The money market is in equilibrium, people aren’t runnning around saying” I can’t find an ATM to get the cash I need” or “The line is so long at the ATM.””

What do you mean by “money market”? There is no (single) market for the MOE. By definition, the market of MOE is *all* other markets. You are talking about the market for bonds, or the market for the MOA.

Scott, this is a carry over question from an old post. I’m confused over the definition of medium of account. In your Zimbabwe example you’re crystal clear – the MOA is whatever shopkeepers use to publicly post prices. It’s in ounces.

But you go on to say that the US during the 1930s until 1968 had a gold MOA. Yet empirically, we see people posting prices in dollars, not ounces. As for debts, the gold clause was illegal.

So it seems like you’re definition of MOA is sliding from that unit in which prices are posted to that unit to which the currency is fixed.

This distinction makes a difference in fixed exchange rate regimes that periodically change the peg. During Bretton Woods, currency were habitually re-valued. Shopkeepers publicly displayed prices in the local currency, not the unit to which it was pegged. So by your definition, what is the MOA?

Or take China. The exchange rate is pegged to the USD, yet the fix is crawling by the day. Shopkeepers show prices in renminbi. What is the MOA?

The unit of account is the word used to quote prices, make contracts, and keep accounts.

Dollar is a unit of account.

The medium of account is a good (or bundle of goods) that is used to define the unit of account.

A dollar is 1/20th of an ounce of gold. The dollar is the unit of account and gold is the medium of account.

It is possible to change the definition of the dollar. The dollar is 1/35th of an ounce of gold. Gold is still the medium of account. The dollar is still the unit of account, but the definition changed.

It is possible to change the medium of account. The dollar is now 1/2 ounce of silver. The dollar is still the unit of account, now the medium of account is silver.

You can have two media of account. The gold is 1/20th of an ounce of gold our 1/2 of an ounce of silver.

It is possible to have a medium of account that has two goods. A dollar is 1/15 of an ounce of gold and 1/4 of an ounce of silver.

The problem with the gold and silver examples is that gold and silver can easily serve as redemption or settlement media. They could also serve as media of exchange. And in coined form, often have served as media of exchange.

Checkable deposits, or the checks drawn on them, can be denominated in dollars–in the unit of account. The deposits form an important media of exchange. The deposits drawn of particular banks don’t serve as the medium of account.

With a gold standard, government-issued, dollar-denominated currency doesn’t serve as the medium of account. Generally, it is tied to the medium of account by redeemability.

With gold, it is easy to make the currency redeemable in gold. Gold is the settlement medium or medium of redeption, but that isn’t a necessary characteristic of the medium of account.

Black had a paper which conceived of a gold standard with zero reserves. Gold is the medium of account and dollar denominated currency exits, but there is no redemptions in gold. The Fed just does open market operations in bonds to keep currency at par. Well, he didn’t take that too seriously, and instead went to “near zero” reserves. Gold redeemability but mostly open market operations to keep the price of currency trading at par.

In practice, sellers nearly always accept at least some unit-of-account denominated media of exchange at par. That is, they accept dollar denominated paper currency or checks at par.

Aha! Bill, thanks for the exhaustive list of definitions. I now know where Scott is coming from. That probably deserves it’s own blog post. Without proper definitions at the outset all you get is misunderstanding.

Bill, the US’s UOA up till 1968 was dollars, its MOA was gold. After 1968 the dollar ceased have an explicit MOA. Is inflation targeting a form of defining the MOA? Seems to me like it is. It defines the dollar as falling x% a year against a basket of consumer goods.

I really don’t like using supply=demand models. The problem with them is the issue of multiple equilibria, the equilibria themselves actually changing over time, small changes in initial conditions creating vastly different circumstances, the instability of equilibria, etc. For example, there’s no reason that we change from one equilibrium to a completely different equilibrium with some sort of a shock/shift.

Does anyone know of any dynamic models for this stuff? I just want to see what you would get depending on the assumptions. I’m not saying that it would result in a better model, I just want to see the results. Does anyone know of any work done on this? Any sort of books/papers done on this stuff? Anything of the sort would be appreciated. I just want to see the impacts of using a dynamic model vs a static model.

“The value of the MoA determines the price level. The MoA has nothing to do with the level of real output consumed.

If the price level, which is the inverse of the “price” of the MoA, is fixed, then the value of the MoA is fixed. The MoA does not determine NGDP.

If the price level, which is the inverse of the “price” of the MoA, is flexible, then the value of the MoA is flexible. The MoA determines P, and consequently NGDP. The MoA still does not determine Y.”

I don’t follow this at all. The fixed price level is the utterly crude and vulgar Keynesian model. The flexible price level is the stupid extreme real business cycle model. Yes, if either of those models are correct then everything I’ve said in this entire blog is wrong. But I’m assuming that neither of those models are correct. The price level is not fixed, and it is not flexible. It is sticky. Monetary shocks (MOA shocks) affect NGDP, and that change is partitioned between prices and output.

“I don’t know if I should bother continuing to post comments here, I don’t know how Scott could possibly have written that last post if he had read all my comments on the previous two.”

I haven’t read them all yet, but I do plan to. There are only 24 hours in a day. And I do have a job that keeps me extremely busy at this time of year.

You said;

“Get it? Because recessions are when you can’t exchange goods for each other. The output gap in the US economy right now is stuff that can be produced, but not exchanged into the hands of their final consumers. Because there’s no flow of money to buy them with. Exchange needs a medium, but misses it. The MoA determines the nominal size of the available MoE, and affects things that way. But without MoE, MoA determines the price level (when flexible) but has nothing to do with the level of output consumed.”

The economy is swimming in money. The base has tripled. There is no “shortage” at all. The increase in the demand for base money has reduced NGDP. The problem is that NGDP is too low relative to wages for companies to be able to profitably produce output at normal levels. We don’t get recessions every time spending falls, we get recessions when spending falls 20%. When nominal wages also fall by 20%, there is no recession.

You said;

The MoA does not determine “NGDP”. It determines P, when P is flexible. Because P is the inverse of the price of MoA.”

This makes no sense to me. How can something determine P but not PY? Are you saying that an increase in P will be offset by a fall in Y? Are you claiming monetary stimulus will increase prices and reduce output? You can’t be. So if it increases P, then ipso facto it increases NGDP.

You said;

“Suppose now that instead of exchanging MoA directly for Y, we exchange it for a separate MoE (“silver”). There is excess demand for MoA.”

I’m assuming that the market for the MOA always clears. I am assuming you can freely exchange silver for gold at the free market price. That’s how things actually work in the real world.

You said;

If the price level is fixed (enabling recessions)”

You don’t need a fixed price level to enable recessions. If prices are sticky then a negative monetary shock will reduce both P and Y.

You said;

“Either way, a rise in the real value of gold (relative to goods) will push down prices (and employment, when there is a MoE). It will do so by reducing the nominal value of the currency stock.”

Gold pushed down prices sharply in the early 1930s, even though the US monetary stock rose sharply. People were not refraining from purchases because they lacked money in their wallets, they had record amounts. Rather the cause of lower purchases was a fall in NGDP caused by gold hoarding, combined with sticky wages. That reduced OUTPUT. Falling out IS A RECESSION. Falling purchases is just a side effect.

That previous comment took me a long time to write, and it addressed less than 10% of Saturos’s recent comments. And people wonder why I’m running behind. I basically have no life other than the blog.

Saturos, You said;

“If we had denominated prices in gold-ounces, and left the gold-currency exchange rate flexible, appreciating gold reduces the nominal value of the same stock of currency-dollars.”

It’s not obvious that the demand for currency falls in a recession, but it might. In that case the equilibrium currency stock (in MOA terms) would fall. I agree. So would the equilibrium level of steel output. But those are EFFECTS of the recession. The cause would be the appreciation of gold.

In the Nick Rowe example you cite (what really really causes the recession) currency is the medium of account. So I completely agree with Nick, the fact that the stock of currency is endogenous under some policy regime, doesn’t prevent currency (the MOA) from being the causal factor.

You said;

“Nick, can you please also explain to Scott that velocity is the rate at which money turns over (on average), because it is the inverse of the desired stock of money in equilibrium (as a fraction of nominal income)?”

You can only do that by defining V in an utterly meaningless way. It’s how often money is spent, on average, except when it’s spent at garage sales, or on intermediate goods, or on assets. And then we have to augment it to incldue barter, which adds to NGDP, but does not invlove money transactions. If you do all that, you are bascally back to the tautology: V = PY/M. With k there is no need for qualifiers, it is exactly what it claims to be; the share of gross income held as money.

Scott, I used the extremes of price adjustment to illustrate the point, not because they are realistic. Just like we start by pretending there is no friction, etc. when beginning a course in physics. We can evaluate intermediate cases by combining the elements. You are clutching at straws here.

If the stock of gold (MoA) falls by 50%, with unit-elastic demand, and the price level consequently falls by 25%, but then gets stuck, then the effect of the remaining 25% downward pressure on the price level depends on whether there is also a MoE. If there is, output falls 25%. If there isn’t, then nothing else happens. In the latter case the gold market couldn’t reach equilbrium, as the failure of the price level to fully adjust logically implied a failure of the gold market to fully adjust. And the required doubling of the value of gold only leads to a fall in “NGDP” of 25%. Because without a MoE, gold cannot determine the “Y” part of NGDP, only the “P” part. It is in that sense that I claimed that gold doesn’t really determine NGDP.

“I’m assuming that the market for the MOA always clears.”

You cannot logically assume all of the following:

– that the market for MoA always clears
– that the MoE is irrelevant/doesn’t exist
– that the price level is not completely flexible

I have explained all this before.

Please don’t do any more blog posts on this subject until you find the time to read all my comments, where I have already addressed all your objections.

It’s not obvious that the demand for currency falls in a recession, but it might. In that case the equilibrium currency stock (in MOA terms) would fall. I agree. So would the equilibrium level of steel output. But those are EFFECTS of the recession. The cause would be the appreciation of gold.

The appreciation of gold is actually another EFFECT. You ought to consider the cause of the appreciation of gold. It doesn’t happen for no reason.

“See, you get it now. Without an MoE in the picture, there is deflation, but no recession. You see?”

No, because deflation causes recessions. That’s Irving’s Fisher’s model. Because wages are sticky, falling prices leads to higher unemployment. And that’s not just a theory, it’s exactly what happened in 1921.

JP, We had a dual MOA in 1934-68, but because it was illegal for Americans to own gold, that period isn’t a very good example. Stick with the Zimbabwe example.

Nick, You said;

“We are on the same page. I would say it differently. ‘A huge rise in demand for gold makes the silver price of gold soar, which reduces the real stock of MOE when priced in MOA terms, which creates an excess demand for MOE/excess supply of all other goods that have sticky prices, which is a recession’.”

In that case we agree. I was simply trying to show that Zimbabwe could print zillions of Z$s and still have deflation, at least if gold was its MOA and Z$s were its MOE. Then I argued that according to 4 of the 5 definitions of inflation, the MOA, not the MOE was determining the rate of inflation.

Bill, Black was right, you can simply target gold prices, w/o holding gold as a reserve.

Ron, Silver market shocks have no impact on the economy, it just changes the price of gold in terms of silver.

Nick and Saturos, I’ll do another post soon to see if we can find some common ground.

Because wages are sticky, falling prices leads to higher unemployment. And that’s not just a theory, it’s exactly what happened in 1921.

Scott, now you are talking about higher real wages. I explicitly admitted at the very start that this was a non-MoE mechanism for causing unemployment. But we also both agreed that unemployment goes beyond people being priced out of work at higher real wages. It is also lower demand for labor at the same real wage, because their outputs cannot be sold. Because there isn’t enough demand (in terms of people willing and able to exchange money for output) for them.

The economy is swimming in money. The base has tripled. There is no “shortage” at all. The increase in the demand for base money has reduced NGDP.

The economy is absolutely NOT “swimming” in money. That’s the whole problem! Sure, the money is all out there. In bank vaults, gathering (electronic) dust.

If the money were “swimming around”, it would be passing through from consumers to producers and back again. Everyone would be selling everything they wanted to. Keynesians would not be celebrating the potential for hurricanes to get the government to spend other people’s money, which would create jobs, and then the recipients of the money would not hold the money but spend it, and create more jobs, whose recipients would not hold the money but spend it again. The money would keep flowing. Its velocity of circulation (I literally mean velocity, in the physics sense) would rise. And all the unsold Y, the “fallen NGDP”, could be sold again, at whatever price level the economy had gotten stuck at.

Because the people who made the Y don’t want it for themselves. They don’t want to give it away for free. They want to exchange it for other Y. And the only reason they are not doing that, same as they used to, is because the consumers who want the Y don’t have MoE to pay with.

There’s plenty of MoE around, of course. But no one wants to spend it. If they all did, then people would immediately find that the money they spent had reappeared in their pocket, as someone else spent their money. Their money balances wouldn’t decline. Just as they aren’t currently declining, as everyone who spends is making somebody else receive. If everyone spent more, everyone would receive more. The size of the outflows is the size of the inflows.

But nobody wants to spend more individually. Even though if they all did, their incomes would be higher. It’s the greatest of all coordination failures.

So there’s plenty of money in the system. And yet no one is spending much of it. It isn’t flowing around very much. And so there are no money flows enabling outputs to be sold, so that workers can be paid, so that workers can spend their paychecks, so that outputs can be sold…

It’s the circular flow of income. As everyone seems to forget, that circular flow presupposes money. Otherwise there would be no exchanges in that flow. Without a flow of money, the flow of goods stops.

This is stuff that could (should) be taught at elementary school.

NGDP is equal to the volume of money flowing. Money, times the number of times each unit of money is spent on final output Y.

The flow of money falls when the demand for holding money exceeds the available stock of it, at a given level of nominal income. As the flow falls, nominal income also falls, and so does the demand for holding money. Eventually the demand equals the supply again – but only at a much lower level of nominal income, which has fallen due to a smaller nominal flow of money that it can be sold for.

Yes, I notice that that Y doesn’t include goods that are bartered. You will also notice that barter goods are completely unaffected by “a collapse in NGDP”. I even posted a link in an earlier comment to empirical evidence of that. (If you can find it.)

In that case we agree.

No, you really don’t. Because you still don’t get that there are no falls in output at the same level of real wages, unless something happens to the MoE. The MoA can cause that something to happen. But the MoE needs to be there.

Imagine a market where X is traded for Y. X and Y cannot be traded for anything else, only each other. So there are no substitution effects. And everyone who has X or Y wants to sell it all.

What will be the equilibrium price, under perfect competition?

Suppose each X and Y is consumed as soon as it changes hands. Then the equilibrium price of X in terms of Y, is Y/X. Right? And the equilibrium price of Y in terms of X is X/Y. (I use the letters to represent the amount of each commodity available, as well as the commodities themselves.)

Now suppose that the X sellers and the Y sellers are actually the same people. (You come up with the story for why they are exchanging.)

So people sell Y for X. They then take the X they received, turn around and buy some more Y from someone else.

Suppose that each Y changes hands only once. Each Y only enters one transaction. (So the two trades of X for Y, mentioned above, involved two separate units of Y.)

But each X changes hands twice. Each X enters two transactions, in the period we are looking at. (So the two trades of X for Y, mentioned above, involved the same unit of X, bought and sold twice.)

What is the equilibrium price now? Still assuming perfect competition.

Isn’t the equilibrium price of Y in terms of X, now 2X/Y? I.e. the stock of X times the velocity of X (each X changed hands twice on average) divided by the stock of Y times the velocity of Y.

X times V of X, is the volume of the total flow of X, traded on the market for Y. And if there are no substitution effects then that volume will be constant at every price (ceteris paribus).

Do you not visualize flows of commodities being balanced off at the appropriate market-clearing ratio? How do you see markets?

Scott, I will simply conclude by noting that you are still failing to adequately distinguish between monetary stocks and flows. Just like every other unenlightened economist out there.

Worse still, I think you have been commiting a fallacy which is not entirely unrelated to the one you regularly lambast conventional economists for. Just like you scold them for looking at the symptoms of changing monetary policy, like interest rate changes, instead of the supply and demand for money, and instead of the actual nominal variables which policy is all about – so too are you making such a mistake.
Your focus on NGDP has been the mere symptom of a mismatch between the flow of MoE (M*V), and the average price at which GDP is traded for MoE (P). Such a disconnect will cause Y to fall.

But because the MoE is also the MoA, or nominally valued by the MoA (like the French and the Sun), – MoE fluctuations correspond to MoA fluctuations. And the change in the exchange rate between the MoE and Y-in-general, is called a change in the “nominal price level” (because it so happens that prices are denominated in the MoE). And once the price level gets stuck, further falls in the MoE stock (or increases in the demand to hold it), which reduce the amount of output sold, also correspond to falls in the MoA stock.

And so you say, “The MoA controls NGDP. Recessions happen when NGDP, controlled by MoA, falls – and prices do not absorb the whole decline. So output has to.”

Can you see that it is you who are looking through “the wrong end of the telescope” this time?

Again, what is the mechanism by which a change in the MoA stock affects real gdp? You say, it reduces NGDP, which is P*Y, so Y falls when P doesn’t.

But that’s just rearranging the question. Why does Y fall? How does the MoA affect the Y part of NGDP? Why should people lose their jobs when the demand for MoA rises? So what if prices stop falling, and there is still excess demand for MoA. How does that remaining excess demand for MoA put people out of work? How does that remaining excess demand affect Y, when it no longer affects P?

What else do I need to do to convince you?

But I’m still hoping for a Kuhnian breakthrough with you here. After all, even Nick Rowe needed to have one, once upon a time…

And people wonder why I’m running behind. I basically have no life other than the blog.

Scott, it’s OK, I’m probably more obsessed with this blog than you are. As you can see from the comment sections.

Scott, although I can’t say I’m looking forward to the next post in this saga (my head has taken a beating against the wall as it is) – I think we have plenty of common ground. We both agree on what needs to be done to save the world economy. (We just disagree on why it would work!)

On a wholly unrelated note, did you hear that Disney (which bought Lucasfilm) is going to make the Star Wars sequels? Any thoughts?

Be aware, though, that when Garrett Watson talks about excess demand for money, he is conflating excess demand for monetary stocks and flows (as even MMs often do). At first, there is an excess demand for monetary stocks. This is resolved at a lower level of real income (and prices). And then there is an excess demand for monetary flows.

Saturos, After the first two Star Wars I sort of lost interest. But I’ll watch them. Even at their worst, they’re better than 2 hours of real life.

You said;

“Scott, now you are talking about higher real wages. I explicitly admitted at the very start that this was a non-MoE mechanism for causing unemployment. But we also both agreed that unemployment goes beyond people being priced out of work at higher real wages. It is also lower demand for labor at the same real wage, because their outputs cannot be sold. Because there isn’t enough demand (in terms of people willing and able to exchange money for output) for them.”

You view the problem as sticky prices plus too little MOE. I view it as sticky prices plus too little NGDP caused by an overvalued MOA.

You said;

“The economy is absolutely NOT “swimming” in money. That’s the whole problem! Sure, the money is all out there. In bank vaults, gathering (electronic) dust.”

Even cash holdings are high–I’ll do a post on this soon.

You said;

“Because the people who made the Y don’t want it for themselves. They don’t want to give it away for free. They want to exchange it for other Y. And the only reason they are not doing that, same as they used to, is because the consumers who want the Y don’t have MoE to pay with.”

I think they do have it in their wallets, it’s just that their demand for MOE/MOA is currently pretty high, depressing the price level.

You said;

“But nobody wants to spend more individually. Even though if they all did, their incomes would be higher. It’s the greatest of all coordination failures.”

I completely agree. But I think the coordination failure is too much demand for MOA.

You said;

“The MoA can cause that something to happen. But the MoE needs to be there.”

The MOA causes recessions, but the MOE, the labor market, the product market and so on have to be there to facilitate production and exchange. But the MOA is what causes it to happen.

Anyway, if Money is primarily a MOA then price inflation causes companies to overstate their profit in real terms by the inflation rate. This means that a lot of companies think they are viable when they really are not. This is because the costs on their books are often the uninflated prices, but their profits and revenues are in inflated terms. Could this be another harmful result of the money illusion?

Fed Up, I guess it would be central bank deposits, at least according to Nick and Scott’s logic. The concept of the MOA is new to me so don’t take my word as gospel. My first thought was that the modern day MOA was the CPI inflation basket. Maybe I’ll write about that one next week.

[…] State of Chu, gold has not been (pdf) a significant monetary metal in China. Silver was often a medium of account in Chinese history, but characterising that as a “gold standard” for definitional […]

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.